As the public’s exposure to digital assets increases, everyone from institutional investors to individual enthusiasts and curious dabblers alike will be wise to consider the accompanying increased legal exposure. One example of an emerging area of law surrounding digital assets relates to various false claims acts (“FCA”). Several states authorize FCA suits based on tax claims. Specifically, Delaware, Florida, Illinois, Indiana, Nevada, New York, Rhode Island and the District of Columbia authorize FCA suits based on tax liability due to not reporting income. State attorneys general are poised to be at the forefront of this emerging area of law.
Recently, New York Attorney General Letitia James issued a warning to digital asset investors and tax advisors. The warning was clear: pay taxes on virtual investments or risk being the target of an FCA investigation. Notably, James cautioned “[t]he consequences of a taxpayer’s failure to properly report income derived from transactions involving cryptocurrency are potentially far-reaching and severe” and could “result in taxpayer liability under the New York False Claims Act, which carries with it triple damages, interest, and penalties … New York False Claims Act liability may also extend to tax professionals advising clients about the taxability of cryptocurrency transactions.” Given the frequent collaboration amongst state attorneys general, James is not alone. Indeed, in 2021, the District of Columbia amended its FCA, closely tracking New York’s statute. Washington, D.C.’s amendment enables the D.C. attorney general to bring FCA cases based on tax claims. The amendment also incentivizes private citizen whistleblowers to file qui tam complaints by providing between 15% and 30% of any recovery. D.C.’s FCA provides both civil and criminal penalties.
In light of the above-referenced FCA exposure, digital asset investors should consider potential taxable events. The most obvious example of a taxable event is cashing out of a digital asset investment. Other potential taxable events are less obvious. For example, crypto-to-crypto trades could be taxable events. Earning cryptocurrency through paychecks, staking or mining are taxable events. Likewise, using cryptocurrency to purchase goods or services would likely be such an event. To retain the ability to accurately report taxable events, investors should keep in mind the purchase date of a digital asset, the purchase price, the sale date, the name and quantity of each digital asset sold, and the market value of the digital asset at the time of sale.
Federal policy makers have also begun to focus on digital assets. The Infrastructure Investment and Jobs Act of 2021 (P.L. 117-58) included a provision to require brokers to report, for federal tax purposes, the transfer of digital assets to non-brokerage accounts. In addition, the White House recently included in its Fiscal Year 2023 budget several proposals related to digital assets. The proposals would:
- clarify that certain loans of securities involving digital assets would be tax-free;
- provide for information reporting for digital assets held in the United States by foreign persons and foreign passive entities;
- require U.S. taxpayers to disclose foreign accounts that hold digital assets in excess of $50,000; and
- modify the mark-to-market rules to allow a trader or dealer to elect to mark-to-market actively traded digital assets.
While none of the proposals have been enacted, Washington, D.C., is increasingly interested in identifying taxpayers with digital assets and ensuring that there is no tax avoidance.